The debenture holder is considered as the creditor of a company. They get a fixed rate of interest even if the company makes no profit.
Here what you learn today
- What is Debentures?
- Features of Debentures?
- Why it is beneficial for you to Finance from Debentures?
- Things should not be avoided when you opt for Finance from Debentures.
What is Debentures?
A company may wish to borrow money from persons who are willing to lend instead of buying shares. money received as a loan is called Borrowed capital. Now we are going to deal with it.
The money lent to the company must be recorded unacknowledged by the issue of a document which is called a ‘debenture‘. The company may raise long term loan by the issue of debentures.
The word debenture has been derived from the Latin word “debere” which means “to owe”. Debenture is a debt instrument.
Debentures include debenture stock, bonds, and other securities of a company, whether constituting a charge on the assets of the company or not.
Like shares, debentures issued at par, with premium or at a discount, and maybe redeemed when the company has surplus funds.
They are normally payable at the end of the period for which the loan is taken.
Please keep in mind the most important thing that debenture holders have no control over ownership and management.
Features of Debentures:
- Debentures are secured through a charge on the present and future immovable assets of the company. This is called an equitable mortgage.
- A fixed-rate of interest is payable annually or half-yearly and quarterly on the value of debentures.
- Although debentures provide long term finance to a company, they mature after a specific period at a definite time as stipulated in the issue.
- A debenture redemption reserve (DRR) is created with at least 50% of the amount of issue /redemption before the commencement of redemption for purpose of redeeming all debentures which have a maturity period of more than 18 months.
- professional bodies, such as CRISIL, ICRS, CARE, etc. rate debentures to indicate the degree of their safety.
- Meanwhile, the debenture holders are treated as the creditors of the company they don’t have any control over the management of the company.
- Above all, Debenture holders enjoy preferential claims on the income of the company over shareholders.
Why it is beneficial for you to Finance from Debentures:
From the point of view of the company:
- Firstly, the Company can raise the medium term and long term finance through the issue of debentures.
- The cost of debentures i.e. interest paid to debenture holders remains fixed.
- Interest paid on debentures is a tax-deductible expenditure and thus reduces the tax burden of the company.
- most importantly, the rate of interest paid on debentures is lower than the rate of dividend paid on shares.
- Above all, you can raise funds through the issue of debentures even during the depression since the risk of investing in debentures low and debentures are a source of stable income.
From the point of view of debenture holders:
- Debentures are a good investment from the point of view of cautious investors who do not want to risk their investments too much and yet wish to earn high and regular income.
- Generally, debentures have a fixed maturity period and many investors prefer this instrument because of a fixed maturity period.
- Moreover, In the event of liquidation, debenture holders enjoy a preferential claim on the assets of the company over the shareholders.
- further, A debenture is more a form of liquid investment and an investor can obtain loans from financial institutions by mortgaging or selling debentures.
- Debenture holders get a regular fixed rate of interest which is payable by the company even out of capital if profits are not available. So, debentures provide a stable source of income to its investors.
Things should not be avoided when you opt for Finance from Debentures
From the point of view of company:
- Payment of interest on debenture and repayment of the principal amount on maturity are the permanent liabilities of the company.
- On the other hand, Failure in payment of interest on time and repayment of the principal amount adversely affect the creditworthiness of the company and may force the company to go into liquidation.
- on maturity, the debentures to be redeemed compulsory. It threatens the liquidity position of the company except in the case of convertible debentures.
- most importantly, the use of too much debt financing may push the market price of equity shares down.
- Above all, the Cost of issue of debentures for raising finance is also high because of high stamp duty.
From the point of view of debenture holders:
- Having no right of voting, debenture holders do not have any controlling power over the management of the company.
- The interest received by the debenture holders is fully taxable in their hands which they can avoid by way of equity dividend.
- In the case of a new company, it is very difficult for a prospective investor to decide on the financial future. They cannot have faith in the investment of debentures despite its guaranteed fixed regular interest income, rather they like to invest in shares of such a company.
- subsequently, the prices of debentures in the market fluctuate with the changes in the interest rate.
- Debenture holders get interest only at a fixed rate. They cannot participate in the surplus profit nor surplus assets of the company.
For example, A power company issued an interest bearing bond for Long-term financing is an example of a debenture.
Treasury bonds or T-bond issued by the government can be an example of a Source of Finance from Debentures.
In short, Debentures enable you to raise finance without giving any control to the debenture holders, but remember too much debt also not healthy for a business
So, guys, I hope I solved your problems regarding the issue of Debenture finance.
Also read my further blogs related to finance:
A. The debentures which cannot be converted in Equity shares.
A. Yes, It is a Debt capital, company have to pay fixed rate of interest annually to the debenture holders.
A. The rate of interest payable on debentures is fixed as well as lower than the rates of dividend paid on shares.
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A commerce student from Kolkata.